Principles of Accounting I Final (BIOLA)

Study guide for principles of accounting I final.

What are the three activities of accounting?

• Identification: Recognizing economic events relevant to the business.

• Recording: Systematically recording transactions.

• Communication: Preparing financial statements to share information.

What does the identification activity in accounting involve?

Recognizing economic events that are relevant to the business, such as a sale or purchase.

What does the recording activity in accounting involve?

Keeping a systematic record of transactions, such as logging a sale in a journal.

What does the communication activity in accounting involve?

Preparing and sharing financial statements, such as the income statement and balance sheet.

Who are the users of accounting data?

• Internal Users: Managers, supervisors, etc., for decision-making.

• External Users: Investors, creditors, and regulators, for assessing business performance.

What is the difference between internal and external users of accounting data?

• Internal Users use data for operational decisions (e.g., managers).

• External Users use data to evaluate the company’s financial health (e.g., investors).

What are the four building blocks of accounting?

• Ethics: Ensures integrity in financial reporting.

• Generally Accepted Accounting Principles (GAAP): Framework of rules and standards for consistency.

• Principles: Specific guidelines like Revenue Recognition and Matching Principles.

• Assumptions: Foundational ideas like Monetary Unit and Economic Entity Assumptions.

Why is ethics considered a building block of accounting?

Ethics ensures trust and accuracy in financial reporting, preventing fraud and misleading information.

What is GAAP, and why is it important?

GAAP (Generally Accepted Accounting Principles) provides a standardized framework for recording and reporting financial transactions, ensuring consistency and comparability.

What are some key principles of accounting?

• Revenue Recognition Principle: Revenue is recognized when earned, not when cash is received.

• Matching Principle: Expenses are recorded in the same period as the revenue they help generate.

What are the key assumptions in accounting?

• Monetary Unit Assumption: Only transactions measurable in money are recorded.

• Economic Entity Assumption: Each business is treated as a separate entity.

What is the basic accounting equation?

Assets = Liabilities + Owner’s Equity

What is the expanded accounting equation?

Assets = Liabilities + Owner’s Capital – Owner’s Drawings + Revenues – Expenses

What is an asset, and what are specific kinds of assets?

Definition: Resources owned by a business that provide future economic benefits.
Examples: Cash, accounts receivable, supplies, equipment, inventory.

What is a liability, and what are specific kinds of liabilities?

Definition: Obligations a business owes to others.
Examples: Accounts payable, loans, unearned revenue, salaries payable.

What is owner’s equity?

The owner’s claim on the company’s assets after liabilities are subtracted.
Subdivisions:

1. Owner’s Capital

2. Owner’s Drawings

3. Revenues

4. Expenses

How do you analyze transactions to determine if assets, liabilities, or owner’s equity increase or decrease?

• Identify accounts affected: Is it an asset, liability, or equity account?

• Determine the change: Does it increase (debit) or decrease (credit)?

  • Example: A company purchases equipment (assets increase), paid with cash (assets decrease).

What is an income statement, and what does it tell you about a company?

• Definition: A financial statement showing the company’s revenues and expenses for a specific period.

• Purpose: It shows whether the company made a net income (profit) or a net loss.

How do you calculate net income or net loss?

Net Income = Total Revenues - Total Expenses

• If expenses > revenues, the result is a net loss.

What is an Owner’s Equity Statement, and what does it tell you about a company?

• Definition: A statement summarizing changes in the owner’s equity during a specific period.

• Purpose: It shows how much capital the owner has invested or withdrawn, and the impact of net income/loss.

What is a balance sheet, and what does it tell you about a company?

• Definition: A snapshot of a company’s financial position at a specific point in time.

• Purpose: It shows the company’s assets, liabilities, and owner’s equity.

What are the three main financial statements you should be prepared to create?

• Income Statement: Reports revenues and expenses.

• Owner’s Equity Statement: Shows changes in equity.

• Balance Sheet: Displays assets, liabilities, and equity.

How are accounts, debits, and credits used to record business transactions?

• Accounts: Categories for organizing financial transactions.

• Debits: Represent increases in assets or expenses; recorded on the left.

• Credits: Represent increases in liabilities, equity, or revenues; recorded on the right.

What are the debit and credit rules (DEA/LER)?

• DEA: Dividends, Expenses, and Assets increase with Debits.

• LER: Liabilities, Equity, and Revenue increase with Credits.

What is the recording process in accounting?

• Identifying and analyzing transactions.

• Recording journal entries in the General Journal.

• Posting entries to the General Ledger.

What is the General Journal?

A book where all business transactions are recorded in chronological order. Each entry includes:

• Date

• Accounts involved

• Debit and credit amounts

• Explanation of the transaction.

How do you journalize transactions?

• Identify accounts affected.

• Determine whether to debit or credit the accounts.

• Record the transaction in the journal with the correct amounts.

What is the General Ledger, and what purpose does it serve?

• Definition: A collection of all accounts used by a company, each showing individual balances.

• Purpose: Helps organize and summarize transactions for creating financial statements.

How do you post amounts from journal entries to the General Ledger?

• Transfer each debit and credit from the journal to the respective ledger account.

• Update account balances.

What is a trial balance?

A list of all accounts and their balances at a specific date to ensure total debits equal total credits.

What is the accrual basis of accounting?

Definition: Revenues are recorded when earned, and expenses are recorded when incurred, regardless of cash movement.

What are the Revenue Recognition and Expense Recognition Principles?

• Revenue Recognition: Revenue is recorded when earned.

• Expense Recognition: Expenses are matched to the revenues they help generate.

Why do we need adjusting journal entries?

To ensure that revenues and expenses are recognized in the correct period, aligning with the accrual basis of accounting.

How do you journalize deferral adjusting journal entries?

Adjust prepaid or deferred items like:

1. Supplies: Record used amount as an expense.

2. Prepaid Insurance: Transfer expired portion to expense.

3. Unearned Revenues: Recognize earned portion as revenue.

How do you journalize accrual adjusting journal entries?

• Accrued Revenues: Record revenue earned but not yet received.

  • Example: Accounts Receivable.

• Accrued Expenses: Record expenses incurred but not yet paid.

  • Example: Salaries Payable.

What is the purpose of an adjusted trial balance?

It ensures that all adjustments have been recorded and that total debits still equal total credits before preparing financial statements.

How do you prepare financial statements using an adjusted trial balance?

• Income Statement: Use revenue and expense balances.

• Owner’s Equity Statement: Include net income/loss and withdrawals.

• Balance Sheet: Include assets, liabilities, and equity.

How do you journalize closing entries?

• Close Revenues to Income Summary.

• Close Expenses to Income Summary.

• Close Income Summary to Owner’s Capital.

• Close Owner’s Drawings to Owner’s Capital.

How do you prepare a post-close trial balance?

• Include only permanent accounts (assets, liabilities, and equity).

• Verify that total debits equal total credits.

How do you prepare correcting entries?

• Identify the incorrect journal entry.

• Reverse the incorrect part of the entry.

• Record the correct entry.

What are the steps of the accounting cycle?

• Analyze transactions.

• Journalize entries.

• Post to the ledger.

• Prepare a trial balance.

• Adjust entries.

• Prepare an adjusted trial balance.

• Prepare financial statements.

• Close entries.

• Prepare a post-close trial balance.

What are the various sections of a classified balance sheet?

1. Current Assets: Cash, accounts receivable, inventory, etc.

2. Long-term Investments: Stocks, bonds, or land held for future use.

3. Property, Plant, and Equipment (PPE): Buildings, equipment (minus depreciation).

4. Intangible Assets: Patents, copyrights.

5. Current Liabilities: Accounts payable, salaries payable.

6. Long-term Liabilities: Mortgages, bonds payable.

7. Owner’s Equity: Owner’s capital account.

What is the advantage of a perpetual inventory system over a periodic system?

A perpetual system:

• Continuously updates inventory records after every purchase or sale.

• Provides real-time inventory data for better decision-making.

What are the key terms related to purchasing inventory for a merchandising company?

• Freight Costs: Shipping expenses (FOB Shipping Point or FOB Destination).

• Purchase Returns: Items returned to the supplier.

• Purchase Discounts: Discounts for early payment, e.g., "2/10, n/30".

How do you calculate the cost of inventory?

Cost of Inventory = Purchase Price + Freight (if applicable) - Returns - Discounts

How do you record journal entries for purchasing inventory using the perpetual system?

• Purchase Inventory on Account:

  • Debit: Inventory

  • Credit: Accounts Payable

• Purchase Returns:

  • Debit: Accounts Payable

  • Credit: Inventory

• Purchase Discounts:

  • Debit: Accounts Payable

  • Credit: Cash (net of discount) and Inventory (discount amount).

What are the journal entries for selling inventory using the perpetual system?

• Selling Merchandise on Account:

  • Debit: Accounts Receivable

  • Credit: Sales Revenue

  • Debit: Cost of Goods Sold

  • Credit: Inventory

• Sales Returns and Allowances:

  • Debit: Sales Returns and Allowances

  • Credit: Accounts Receivable

  • Debit: Inventory

  • Credit: Cost of Goods Sold

• Sales Discounts:

  • Debit: Cash (net amount received)

  • Debit: Sales Discounts

  • Credit: Accounts Receivable.

What are the sections of a multi-step income statement, and how are they calculated?

• Net Sales: Sales Revenue - Sales Returns, Allowances, and Discounts.

• Gross Profit: Net Sales - Cost of Goods Sold (COGS).

• Operating Expenses: Selling, administrative, and other expenses.

• Income from Operations: Gross Profit - Operating Expenses.

• Non-operating Activities: Gains, losses, interest revenue/expense.

• Net Income: Income from Operations ± Non-operating Activities.

Why do companies check inventory quantities at the end of a period?

To ensure the accuracy of inventory records and account for shrinkage, theft, or errors.

What are the two "terms of sale" used to determine ownership of goods in transit?

1. FOB Shipping Point: Buyer owns goods during transit.

2. FOB Destination: Seller owns goods until delivery.

What is the formula for calculating the cost of goods available for sale?

Cost of Goods Available for Sale = Beginning Inventory + Purchases

What are the three cost-flow methods for inventory?

• FIFO (First-In, First-Out)

• LIFO (Last-In, First-Out)

• Average Cost

What is Lower-of-Cost-or-Net Realizable Value (LCNRV)?

LCNRV is the rule that inventory is reported at the lower of its historical cost or its market value.

What are the three factors that contribute to fraud?

• Opportunity: Lack of sufficient controls.

• Incentive: Personal financial pressure.

• Rationalization: Justifying dishonest behavior.

What is the importance of a bank reconciliation?

It ensures the company’s book balance matches the bank balance, identifying errors or missing transactions.

What are the key accounts related to receivables?

• Accounts Receivable: Amounts owed by customers.

• Notes Receivable: Written promises to pay.

• Interest Receivable: Interest earned but not yet received.

How do you determine the cost of a plant asset?

Include all costs necessary to acquire the asset and prepare it for use:

• Land: Purchase price, closing costs, site preparation.

• Buildings: Purchase price, remodeling costs.

• Equipment: Purchase price, shipping, and installation.

What is depreciation, and which asset does not depreciate?

• Depreciation: Allocating the cost of a tangible asset over its useful life.

• Land: Does not depreciate because it does not lose value through use.

How do you calculate depreciation using the straight-line method?

Depreciation Expense=Cost - Salvage Value​/Useful Life

How do you calculate depreciation using the units-of-activity method?

Depreciation Expense=(ActivityCost - Salvage Value​/Total Estimated)×Units of Activity for Period

How do you calculate the gain or loss on the sale of a plant asset?

Gain or Loss=Proceeds from Sale−Book Value of the Asset

• Gain: Proceeds > Book Value.

• Loss: Proceeds < Book Value.

How are Property, Plant, and Equipment (PPE) assets presented on the Balance Sheet?

List PPE assets at cost, less accumulated depreciation. Example:

• Equipment: $50,000

• Accumulated Depreciation: ($20,000)

• Net PPE: $30,000.

How do you record the issuance of a note payable and the related interest expense?

1. Issuance:

   • Debit: Cash

   • Credit: Notes Payable

2. Accrued Interest:

   • Debit: Interest Expense

   • Credit: Interest Payable

3. Payment:

   • Debit: Notes Payable, Interest Payable

   • Credit: Cash.

How do you calculate sales taxes and record their collection?

1. Calculate Sales Taxes:

   • Formula: Total Cash Collected ÷ (1 + Tax Rate) = Sales Revenue.

   • Difference is the sales tax amount.

2. Journal Entry:

   • Debit: Cash

   • Credit: Sales Revenue, Sales Tax Payable.

How do you record unearned revenues initially and as they are earned?

• Initial Entry:

  • Debit: Cash

  • Credit: Unearned Revenue.

• Adjusting Entry (when earned):

  • Debit: Unearned Revenue

  • Credit: Revenue.

When are contingent liabilities disclosed in the financial statements?

1. Probable and Estimable: Record as a liability.

2. Reasonably Possible: Disclose in the notes.

3. Remote: No disclosure required.

How do you calculate the present value of $1?

Formula:

PV=Future Value/(1+r)^n

Where:

• r = interest rate per period.

• n = number of periods.

How do you calculate the future value of $1?

Formula:

FV=PV x (1+r)^n